What is Forex Trading?
You might have stumbled upon the vast world of Forex trading when scouring the internet for new ways to invest. Or perhaps you heard about it from a friend or colleague or saw it on the news.
Given its immense popularity and intricate nature, Forex trading can seem daunting to those just starting out. So we’ve broken down everything you need to know about beginning your trading journey in the Forex market.
What Does Forex Mean?
Forex is the abbreviation used for FOR-eign EX-change. It is a market that deals with the exchange of currencies and it is one of the largest markets in terms of trading volumes. It is estimated that the average daily trading volumes in the Forex market are upwards of $5 trillion.
But don’t get intimidated by these figures. Over 95% of this turnover comes from the interbank markets, which brings us to the next question.
Is There A Simple Way To Understand Forex?
Yes, there is! As you might have guessed, in Forex, you are basically trading one currency for another. But remember that you are only speculating on the currencies! You are in no way physically purchasing a currency to be delivered to you when you are trading Forex.
This is in contrast to, for example when you travel abroad. You might have visited a foreign exchange broker on your last holiday and converted your USD to EUR or your GBP to AUD. That is real-life Forex. You’ve physically exchanged one currency for its value of another currency.
In retail Forex trading, no such thing happens. You are merely speculating on how one currency will fare, compared to the other and vice versa.
You could, of course, physically convert your holiday USD to EUR simply to take advantage of the euro’s appreciation. However, you’d have to go back to the money exchange office and convert your euros back to dollars, therefore getting you more dollars!
However, you would probably take a loss overall on exchange commissions the broker would charge.
What Do I Need To Access Forex Trading?
As an FX trader, you must trade through a Forex broker that will connect you to the markets. This is similar to how you would trade stocks for example, where you can’t buy and sell shares directly. You need an intermediary for it.
A Forex broker basically does just that. They connect you to the liquidity pool. Bear in mind that the Forex market is traded over-the-counter (OTC trading). This is in contrast to stocks for example. In an OTC market, you are basically trading with a counterparty, that you wouldn’t know in most cases.
A Forex broker takes your order to buy or sell and passes it further down the line where your order is filled.
What Should I Know Before I Start Forex Trading?
One of the unique things about the Forex market is that you are primarily trading two currencies at the same time. So, when you buy EURUSD, you are buying the EUR and selling the USD at the same time.
This is quite different from other markets such as bonds or stocks, where you outright buy the underlying instrument. The instrument that you buy, the EURUSD, is known as the currency pair.
The minimum price movement in a currency pair is one pip, which is the fourth decimal.
Typically, you might be used to measuring currencies up to cents. This is the second decimal in a currency rate. But if you dig deeper and get to the fourth decimal, that is known as a pip. A pip is a unit of measurement and is used for Forex trading and speculation purposes only.
So, depending on your view on how one currency will perform in relation to the other, you would buy or sell that currency pair. That is Forex trading. The amount of pips that the currency pair moves is the amount of money you can make.
Of course, the profits might seem minimal, after all, a 10 pip move is negligible. FX traders use something called leverage to make that more valuable. This helps them to magnify the small profits into large ones (and the same with losses too).
The above information gives a basic overview of how to get started with Forex trading. We should also caution you that trading Forex is risky. Therefore, it is not suited for everyone. You should analyze the risks and invest only money that you can afford to lose.